Production is likely to flirt with 1m barrels a day as the country's problems mount

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When Opec's Gulf powers, led by Saudi Arabia, decided to keep the taps open in November 2014, flooding an already oversupplied market with crude, their target was America's shale producers. In pushing prices down, Saudi Arabia hoped to sap momentum from the booming tight oil industry and impose discipline on what they saw as profligate drillers. Shale bowed but it didn't break, and has since roared back to new highs.

Venezuela's oil industry hasn't been so resilient, to say the least. That 2014 decision was a fateful one for Caracas and helped break the back of Venezuela's energy sector.

Caracas was in a precarious financial position already, but at the time there was growing optimism among state oil company PdV brass that long-stalled Orinoco projects were finally gathering momentum.

I visited the Orinoco in early 2015 with PdV's chief executive at the time Eulogio del Pino—since arrested as part of a purge of the company's senior leadership. He was keen to point to resurgent drilling activity, new pipelines being laid down around joint-venture heavy oilfields, and fresh plans to get more Orinoco oil out of the ground and onto markets. PdV's foreign partners had been given more autonomy, output was ticking up and there were plans to add more.

Given the company's miserly track record over the previous 15 years, this may all have been wishful thinking, and even if oil prices hadn't crashed, the hurdles were going to be formidable. But as Saudi Arabia kept pumping, and oil prices kept falling, the bottom fell out for Venezuela. Years of economic and oil policy mismanagement left Caracas exposed and the country is now paying the price.

Politicised data

Outside of times of war, there's no parallel to what the oil market is seeing out of Venezuela. Getting a precise picture of Venezuela's output is difficult, given the figures are highly politicised. But the scale of collapse is immense. Production has fallen by 1m barrels a day to 1.7m b/d—a drop of nearly 40% since president Nicolás Maduro took office in April 2013, according to figures the country reports to Opec. A major chunk of that—around 600,000 b/d-was from 2017 alone as conditions around the oil industry deteriorated.

Secondary market sources, which rely largely on tracking tankers, paint an even starker portrait, putting output at around 1.6m b/d. Even that, however, may overstate true production levels. Some close to the industry say that 1.6m b/d figure double-counts certain barrels that are used to dilute Orinoco heavy oil exports, and actual production could be below 1.5m b/d.

An investment shortfall in aging fields around Maracaibo has caused oil production to plummet - Source: Petroleum Economist

Either way, Venezuela is producing less oil now than it has in decades, outside the brief plunge during the 2002-03 oil strike.

The collapse started in the country's mature oilfields. When Hugo Chávez rose to power there was a strategic shift to focus resources on the Orinoco Belt's heavy oil reserves. This came at the expense of investment in aging conventional fields around Maracaibo and other traditional strongholds. These required technically complex, and costly, enhanced recovery to prop up output. As a result, the light and medium grade crudes pumped out by these fields have been falling fast for years. Light oil output fell by nearly half, from 487,000 b/d in 2012 to around 250,000 b/d in 2017. Medium crude output also plummeted by around half, from 875,000 b/d in 2012 to 470,000 b/d last year.

Light crude imports

The declines from these fields has been particularly painful for a couple of reasons. For one, they fetch a higher price on international markets, so Venezuela's exports have been trading at a larger discount to Brent as the mix of exports has been getting heavier. PdV was also counting on domestic light crude supply to use as diluent to enable more heavy-oil production from the newer Orinoco projects. But with not enough light crude to meet domestic needs, PdV has been forced to turn to expensive imports of it, initially from North Africa, then from the US' shale patch, and more recently from Russia, for the diluent it needs.

For several years, rising production from the Orinoco was helping offset some of the losses from the mature fields. But the collapse has more recently taken hold in the Orinoco Belt as well. The grand ambitions laid out by del Pino in early 2015 never panned out. Momentum that year from early production at a handful of joint-venture projects took output to a high for the Orinoco of close to 1.3m b/d.

But the Orinoco, already regarded as doubtful by many of PdV's foreign partners, totally fell off the radar when oil prices collapsed. The state oil company's cash crunch left it unable to pick up the slack. Output from the Orinoco fell to 882,000 b/d at the end of 2017, according to figures obtained by price reporting agency Argus Media—a drop of more than 300,000 b/d from a year earlier and more than 400,000 b/d from the high in 2015.

The country's crumbling heavy-oil upgraders are running at far less than their nameplate capacity. At the same time, PdV hasn't been able to buy enough diluent to maintain production levels.

Exports have also taken a hit, although a collapse in domestic consumption—thanks to the economic crisis—has blunted some of the effect. Shipments abroad dropped below 1m b/d in February this year, according to data from Thomson Reuters, a severe blow to a country that relies on crude exports for the vast majority of its foreign earnings. The 980,000 b/d in exports was down around 360,000 b/d from January.

Dollars dry up

The collapse is evident in the falling amount of oil flowing to the US, Venezuela's most important market. Even as output steadily declined in recent years, PdV managed to keep a steady flow of between 700,000-800,000 b/d going into the US. This was key to the company because most of its other exports either go to China and Russia to repay oil-for-loan deals; or to the Caribbean on preferential terms, and don't generate cash like the US sales.

This clearly changed in mid-2017, when flows into the US took a noticeable dive. By October last year, exports dipped below 500,000 b/d and they're now running at around 400,000 b/d. This is setting off alarm bells in Caracas, with bondholders counting on cash from those US sales to pay off their debt.

Collapsing production has meant there's simply less oil available to export. But other factors have compounded the problem. Sanctions from the Trump administration have spooked America's financial system, leading some established buyers and traders of Venezuelan crude to look elsewhere. Operational problems have added to the woes. Gulf Coast refiners have complained that the quality of crude making it to US shores has suffered.

It's difficult to see much hope for a turnaround anytime soon. The problems that have plagued Venezuela's oil industry are only getting worse as the country's economic and political crisis deepens. Plunging output and exports means there's even less cash than before to invest in new output, even with the rally in the oil price. Foreign investors, even allies like China and Russia, aren't pumping money into Venezuela's oilfields. Major international oilfield service firms have written off hundreds of millions of dollars in assets in the country in the past few months, an indication they don't expect the situation to improve anytime soon.

The exodus of PdV workers is accelerating. The company can't pay a living wage under hyperinflationary conditions and hundreds of thousands of people are fleeing the country. Equipment, like the platforms on Lake Maracaibo, continues to deteriorate due to neglect. The head of the company, Manuel Quevedo, is a military general with no oil industry experience and no credible recovery plan.

The International Energy Agency, often cautious in its prognostications, sees Venezuelan output falling to around 1m b/d by 2020. Others see PdV hitting that ignoble milestone even quicker. For oil markets, it's time to strap in.